PWL publishes monthly Market Statistics which is an invaluable tool in our work with clients. By reviewing what the marketplace has done over a given period of time, we can anticipate how a client's portfolio has performed, in general terms. For example, the December Market Stats tell us that fixed income (bonds) and REITs had positive returns in 2011. Our clients all hold some bonds and generally hold Canadian REITs. Therefore, there should be a positive return on these portions of their portfolios.
We also see that longer term bonds, at an annual return of 9.67%, provided a higher total return (interest plus capital appreciation) than shorter term bonds at 4.65%. The "flight to safety" we saw in 2011, as investors left the equity markets in favour of government bonds, drove the price of those bonds up, resulting in higher return and making bonds, particularly government bonds, expensive to add to a portfolio now. We chose to keep our fixed income allocations in shorter term bonds - when interest rates do increase, we anticipate that bond prices will go down, and that there will be more volatility with longer term bonds. We are risk managers and would rather direct risk on the equity side, using the fixed income portion to maintain stability in the portfolio.
On the equity side, we see that small stocks produced a slightly higher return in 2011 than the “market” in Canada (-7.85% for the TSX Mid and Small Cap and -8.71% for the TSX Composite), but not in the US (-1.93% for the Russell 2000 in C$ vs. 4.51% for the S&P 500 in C$) or Internationally (-13.57% for the MSCI EAFE Small Cap in C$ vs. -9.66% for the MSCI EAFE in C$). In relation to value stocks, we see the value premium did not show in the US (1.85% vs. 4.51%), and only slightly on the International side (-9.57% vs. -9.66%). We expect the small and value premium to show itself over the long term, but know it will not appear every year. We saw the small cap premium in all markets in 2010, and a slight value premium in the US, but not Internationally. For 2011, we can conclude that clients who had small and value tilts on the equity portion of their portfolios will have performance below the "market" when measured against an index with no tilts.
The concept of which benchmark should be used for comparison of relative performance is a topic for another day. Suffice it to say that, for purposes of our meetings with clients, we use our Market Stats as a basis for a discussion on the reasons for both under and over performance, thus helping our clients manage their expectations and avoid common behaviour traps.